Gasp! Is ‘Normalcy’ Returning?

Allow me to introduce you to Yuichiro Miura.

In 1964, Miura spent $3 million, enlisted 850 men and 27 tons of equipment, to ski down Mount Everest for four minutes. The adventure yielded a world ski speed record of 108 miles an hour and a movie that recorded the feat — as well as six deaths.

The banking industry has been skiing down Everest since last fall, and perhaps, just perhaps, it has reached the bottom of the mountain. Or perhaps not.

The Libor-OIS spread suggests that the skiing adventure has ended, courtesy of Liborated:

Bloomberg News reports that the LIBOR-OIS Spread, a key indicator of market confidence and liquidity, has fallen to a 17-month low. The spread, measuring the difference between 3-Month LIBOR and the anticipated average of the federal funds rate, tightened to 32 basis points. In a further significant move, contracts on the futures market anticipated a spread of 25 basis points in 2011. A smaller LIBOR-OIS Spread results from declines in interbank lending rates, placing them closer to historically more stable fed rates. LIBOR stands for London Interbank Offered Rate and is a filtered average of rates that banks charge each other for short-term, unsecured loans. When such interbank lending rates are lower, banks are showing increased confidence in the market.

Former Chairman of the Federal Reserve Alan Greenspan has notably commented that a LIBOR-OIS Spread of 25 basis points would indicate normalcy in the current market, with banks setting lower bedrock rates that would translate into greater availability of credit for all borrowers. The spread averaged 11 points for much of this decade but burst to 364 points following the collapse of Lehman Brothers in Fall 2008.

The TED spread, which measures the difference between three-month Treasurys and the three-month Libor rate, is fast approaching a drop below the 30 threshold.

All this is good — unless housing prices fall precipitously. There are projections circulating around Wall Street of more housing price declines. Overall, the projections see another 14% drop in home prices, with housing in New York, for example, falling another 30%. The numbers say 25 million more homes are headed for negative equity. All it takes is another round of bad economic data and every credit spread in the world will, well, spread out. But let’s not be pessimistic, right?